By Teresa Welsh |
The economy is skating on thin ice. It would be tragic if the Federal Reserve tightened monetary policy at this point.
The reasons are clear, and I'd say incontrovertible. We still have to create millions of jobs to get us back to the level of 2007. Gross Domestic Product is only just starting to grow adequately, but the gap between its potential and actual growth is still enormous. And there is no inflation out there to worry about. Consumer prices are rising by 1 percent this year. The fear is deflation not inflation.
Those who urge the Fed to start tightening now are living a bad dream from the 1970s. They think if inflation rises just a bit it will spread alarm and lead to a new wage-price spiral. This is nonsense. One has to live in the present, not the nightmare past.
So let's look at how far we have to go to worry about inflation. If the economy were operating at full employment, perhaps the inflation hawks would have a small case. Workers would demand higher wages, putting pressure on business to raise prices.
But today's 7.3 percent is still way above anyone's estimate of a contemporary full employment rate. I'd say full employment is perhaps 4.5 percent, others would say 5.5 percent. As I say, a long way to go.
But the 7.3 percent level is not the byproduct of a strong recovery, but the opposite. Millions of people are not looking for work any longer and therefore not among the officially unemployed. You'd have to add more than two percentage points to the current unemployment rate if they were still looking — or even more.
And the extremely slack labor market — which means outright suffering for millions — shows up as predicted in weak wages. Had employment been approaching a decent level, wages would be rising. In fact, wages for most have been falling, adjusted for inflation, for three years now. This is outrageous in a supposed recovery.
Then there's capacity utilization. If our factories were somehow operating at full tilt, maybe there would be upward pressure on prices. But the Fed reports that we are operating at 78 percent or so of capacity. The long run average is 80 percent. But more to the point, the economy hasn't come close to its high points, reached during booms. In the 1990s, for example, capacity utilization reached 85 percent (I am rounding off these numbers).
Now let's look at GDP. The Congressional Budget Office estimates that GDP should grow, after inflation, by 2.2 percent a year. Due to the recession, our national income has fallen way behind. We must grow by well more than that to catch up. And only now is GDP reaching annual growth rates of 2.8 percent. Time to nip that recent progress in the bud? Of course not.
Finally, as I say, there's no darn inflation around. The Fed cannot even meet its target rate of 2 percent annual inflation.
The problem has seriously been compounded by budget cuts under sequestration. Economist Mark Zandi's model suggests it is robbing the economy of 1.5 percentage points of GDP this year and will rob it of 0.75 percentage points next years. We cannot afford this.
So the Fed is doing the heavy lifting. Rather than tightening now, the far stronger case is for further loosening. The so-called Taylor Rule, which computes a Federal Funds rate, now basical zero, would place that policy rate at well below zero.
In real life, that's hard to do. But if we had somewhat more inflation, the real rate would fall. And that should be the goal. We need inflation rates above 2 percent to get real interest rates low enough to stoke adequate investment.
The final fear of the inflation hawks is that one the Fed stops its so-called quantitative easing program, all hell will break loose. But why? The implication is that interest rates will suddenly soar. But the Fed is not also going to raise its Federal Funds rate. And it will end QE gradually.
The nation is still in pain. Fed policy has lost some of its clout, but imagine what the circumstances would have been like had it not intervened aggressively. Now the Fed is all we have, and the risks of staying the course or loosening still more are minimal. The economy is just beginning to strengthen. The CBO estimates that the federal deficit will fall to 2 percent of GDP in 2016.
A phantom fear of inflation will not pressure the Fed to make a tragic mistake — I hope.
About Jeffrey Madrick Senior Fellow at the Roosevelt Institute
Warren Mosler Co-Founder of the Center for Full Employment And Price Stability
Mark Weisbrot Co-Director of the Center for Economic and Policy Research,
Mark Calabria Director of Financial Regulation Studies at the Cato Institute